When they sell their insurance and investment businesses, many advisors realize that they are sitting on a gold mine. The fire sales of the past are giving way to well-planned transactions, with a better buyer-seller balance. Stepped up compliance may be driving this trend.The sweeping changes rocking the industry are also affecting book of business transactions. Lawrence Geller, president of L.I. Geller Insurance Agencies, says the upheaval goes well beyond regulation. Major trends are changing relations between firms and insurers.

“I suspect that any change in regulations regarding commissions and trailers, renewals, book bonuses and independence/ability to incorporate would have a substantial effect on the valuation of a practice,” Other factors would be consolidation among MGAs and manufacturers’ willingness or ability or to deal directly with agents and agencies, Mr. Geller says.

Brian Curry, president of wealth management consulting firm Curry-Henry Group, thinks the current trend is a boon for book of business valuation, especially from the compliance standpoint. With 40 years’ experience in the security sector, he has seen it all.

Mr. Curry thinks that this trend will spur buyer prudence. In mutual funds, commission disclosure rules are also shaking things up, he points out. “The one thing you have to do as a buyer is do your due diligence on the book and on the business style of the broker. Today’s market is not a huge trading market. People are looking for books built on managed money, fee-based business.” He adds that when looking at compliance, it’s part of due diligence to look at the business style of the book. “That’s going to be a part of it…You have to make sure that you buy a clean book,” he told The Insurance and Investment Journal in an interview.

Many players see compliance as much more than a regulatory burden. It is also a prime business opportunity for advisors, says Marie Elaine Farley, vice-president, legal and corporate affairs at Quebec’s Chambre de la sécurité financière. Advisors who focus on practice compliance make succession planning easier, she says.

“You have to think about the value of your book of business. Who wants to buy risks? Well-organized files represent value when you pass the torch to the next generation,” Ms. Farley pointed out at a panel on compliance at the 2013 Insurance and Investments Convention, held in late November.

Fellow panel participant Michel Kirouac, vice-president and general manager of Groupe Cloutier, a managing general agency, agrees. Five years ago, many questioned why compliance should count in the valuation of a clientele, Mr. Kirouac says. Books of business are often sold based on statements of commissions and a list of policies, but no one looks at the file’s status, he says.

“I participate in several transactions between representatives each year. I have seen that compliance features like the presence of physical files or computer files, along with client management software, are becoming more and more important. The better equipped you are, the more easily you can prove your compliance. This is true in insurance, and even truer in investments,” he says.

In a recent interview with The Insurance and Investment Journal, Mr. Kirouac mentioned that well-organized files give a book of business concrete value. “Renewal commissions and the potential for new sales partly determine the value of the clientele, but so do many other factors. Having an exhaustive physical file on paper or digitized that contains financial needs analyses is one example.”

Buyers mainly dread acquiring problems along with a clientele, Mr. Kirouac continues. He recalls many clienteles formed since the 1980s, some of whose advisors may have been inactive for five or six years. Often, these files are poorly documented and the needs analyses are flawed.

“If clients complain about having bought too much insurance or chosen a poor product upon recommendation by their previous advisor, it would be hard for the buyer to demonstrate the reasons behind the clients’ choices if they aren’t documented,” Kirouac explains.

To help advisors sell their books of business, Groupe Cloutier delves into the state of their clientele: physical or data files, comparison tables and projections, financial needs analyses and much more. “It is not just the needs analysis that counts. You also need well organized files, good notes, references from family members, friends, contact, and notes saying why the person chose a particular product,” adds Kirouac.

Compliance a bonus

“The presence of these elements in ensuring good compliance easily raises the value of a clientele by 15% to 25%,” Mr. Kirouac points out. “This may be enough to bring the clientele multiple to four times renewal commissions or more.”

He adds that multiples have evolved quickly in recent years. The era when the network was plagued with fire sales at 1.5 times renewal commissions for a portfolio is fading. “To have a multiple like that, a portfolio really has to be in bad shape,” Kirouac says. “The better things are, the higher the factors. I don’t think we will see 2 to 2.5 times commissions again. Advisors are better organized. More and more entrepreneurs are presenting appealing firms with assistants, IT systems and a good mix of lines of business, which bring in an attractive level of income.”

He adds that a quality portfolio that generates renewals of $50,000 per year may sell at four to five times these renewal commissions. “Do you know many companies that bring in $50,000 per year for an initial investment of $250,000? That’s a 20% annual return.” This potential return is effectively driving the sales multiples. They will continue to rise for large books of business, Mr. Kirouac says.

Lawrence Geller expressed reservations about the use of a fixed multiple to value an insurance and financial services clientele. This kind of multiple may poorly represent the diversity of a client portfolio. The valuation multiples often only partly cover the activities of a book, and do not apply to a varied practice, which includes term, permanent, universal, group for small groups, disability, critical illness and long-term care insurance, along with segregated funds, he points out.

Each line of business requires a different valuation method that must be refined, Mr. Geller explains. He says that renewal flows staggered over time, the clients’ age, demographics, other products held by the same client and activities that the buyer plans to carry out with the client affect the starting multiple. “The valuation would further depend on the ability or willingness of the vendor to remain with the purchaser, to make introductions, etc.,” he continues.

Valuing a book of business is more complex than people think, Brian Curry points out, whether it be securities, mutual funds, life insurance… or even a McDonald’s franchise. “The main features when valuing a book of business are: type and quality of the clientele, the people in the clientele, their age and risk factors, and what their plans are with respect to passing on their assets to children or grandchildren. Clientele profile is an important aspect of coming up with a value.”

Keeping clients on board

All of these factors can let you determine the asset value, but retaining these assets is even more important, Curry insists. It is not enough to base the value of a book of business on the income that it produced in the last three years. “When a book is sold from broker A to broker B, one assumes that the assets are going to stay. That’s not always the case.” There’s a fair amount of due diligence that has to go into the relationship between the broker who currently hold the assets and the clients, and whether that broker can successfully turn the assets over to the new broker, he adds. “On the other side, the broker that’s going to buy the assets has to be of a like kind in quality…and should be able to form the same sort of relationship with the clients,” he explains.

He recommends that both parties sign a clause that foresees a retention factor. “One of the conditions would be that after a period of time, if there weren’t 90% of the assets still on board, then there will be a penalty. You would probably retract 15% of the price.” In a scenario where the selling advisor stays for a period around six months to make sure the transition is smooth and then the acquiring advisor loses the clientele nine months later, then it’s probably the acquirer to blame and not the seller. “But on the other hand, if you buy and the assets walk out the door two months later, then that’s when the penalty clause would kick-in,” Curry explains.

These considerations are particularly important for independent advisors, he adds. Banks and securities brokers own their clienteles. These institutions write two distinct contracts: with sellers and buyers. They also set the transaction price, decide on the buyer and act as negotiators. Independent advisors, in contrast, are on their own.

“Dealing in the independent market is a totally different ball game. The contract is entirely between the buyer and the seller. It’s the model of the principal agent that we see in [networks like] Raymond James and Manulife Securities.” There, the valuation process is best laid in the hands of a third party individual, he says, which will result in a fairer outcome between buyer and seller, says Curry.

Without being as intrusive as banks, some networks whose clientele belongs to advisors do control variables during transactions. On the plus side, advisors who want to sell their clientele within a network can access internal resources for support and financing. Often, the sale takes place between two colleagues in the same network and even between family members.

One example is Manulife Financial’s new Advisory Services division. Its role includes giving advice to both parties during the sale of a book of business. Manulife Bank can offer to finance the purchase of a clientele portfolio.

“Advisors who are thinking of selling tend to undervalue the book of business while buyers generally overvalue it,” André Vaillancourt, managing director, Advisory Services, for Quebec told The Insurance and Investment Journal. “We want to help reduce the price variance and facilitate negotiations, on both the buyer and seller sides.”

Most advisors don’t have a business plan, he said. “We help advisors who are thinking about succession to prepare a few years in advance. These are free services that Manulife reserves exclusively for independent advisors. We don’t try to buy them out; we want to help them grow their business,” Vaillancourt points out. Advisory Services emphasizes good business practices and training programs that let juniors gradually integrate in the firm. In this network, most clientele-related transactions involve family successors.